Page Created:
        July 11, 2011
Last updated:
        July 11, 2011


by Jay Starkman, CPA

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Jay Starkman examines the nearly 100-year history of the depletion allowance and other tax benefits for developing oil and mineral resources. For decades, these bounties have had a haphazard relationship with the need for energy and mineral incentives, and they are overdue for a comprehensive study and revision.

Copyright 2011 Jay Starkman.
All rights reserved.

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The debate over raising taxes on the oil and gas industries cannot be fully understood without knowing the history and rationale of the current tax regime.

The Joint Committee on Taxation recently issued a report, "Description of Present Law and Select Proposals Relating to the Oil and Gas Industry," listing 10 tax benefits enjoyed by the oil and gas industry.1 Indeed, what is needed is not just a review of the tax incentives for the production of oil and gas, but for all minerals that receive favorable treatment.

Early Tax Legislation

These benefits have their origin in tax laws passed almost 100 years ago. Many are historical accidents. Tax reformers still target these 100-year-old tax bounties, but Congress has always been unable or unwilling to fix the perceived problems. A history of the origins and reasons for these tax provisions should be useful to those who claim today's stage to attack or defend this tax regime.

It all began with World War I. Dissatisfied with what it perceived to be an onerous tax burden, the oil industry introduced geological experts who warned that our limited supply of oil would be exhausted in 10 years. Congress responded with generous depletion provisions to stimulate production and protect the prospector or wildcatter. By 1937, Treasury Secretary Henry Morgenthau was calling the provisions "sheer gifts" from the United States to individual taxpayers, corporations, and their stockholders.2

Initially, the tax law allowed cost recovery methods based on the theory that mineral properties were exhausted in the process of producing financial return, and that part of every dollar was a return of capital invested, rather than profit, and should therefore not be taxable. The Revenue Act of 1913 provided for "a reasonable allowance for the exhaustion, wear and tear of property....not to exceed, in the case of mines, 5 percentum of the gross value at the mine of the output for the year for which the computation is made" — in other words, cost depletion of at least 20 years.

In 1916 Congress made cost depletion more specific, allowing as a deduction:
    (a) in the case of oil and gas wells a reasonable allowance for actual reduction in flow and production to be ascertained not by the flush flow, but by the settled production or regular flow; (b) in the case of mines a reasonable allowance for depletion thereof not to exceed the market value in the mine of the product thereof, which has been mined and sold during the year.
This was one of the earliest examples of complex, arcane technical terms in the tax law.

Favorable regulations were soon issued, allowing companies to deduct cost depletion based on the value of their properties as of March 1, 1913:
    With regard to mining corporations, it is stated that in passing on values set up as of March 1, 1913, as a basis for depletion, the department will give due weight to market quotations of capital stock as of that date, and of values stated by the corporations in their capital stock returns. 3
Following the industry-led scare that our oil resources would last but 10 years, Congress adopted a new industry-inspired theory that we must stimulate production and protect the prospector or wildcatter who risked drilling in unknown territory. No distinction was made between the adventurer and Standard Oil's John D. Rockefeller, whose personal fortune would soon be estimated at nearly 2 percent of the American economy.

The solution was a tax incentive that sheltered part of the income from taxation:
    The prospector for mines or oil and gas frequently expends many years and much money in fruitless search. When he does locate a productive property and comes to settle it seems unwise and unfair that his profit be taxed at the maximum rate as if it were ordinary income attributable to the normal activities of a single year. 4
The maximum rate during World War I was 77 percent.

So Congress responded with a 1918 provision for "extraordinary" treatment of taxpayers discovering oil and mineral properties, giving them the right to base their depletion not on March 1, 1913, values, as previously determined, but on the fair market value of the property at the time of discovery. The Revenue Act of 1918 extended to the owners of mines and oil and gas wells a benefit that other property owners did not have: a markup on property value for the discovery of new natural resource deposits. Insofar as oil was concerned, this provision made sense in the light of its premise — a pending scarcity of oil.

Common industry practice of land leases allowed deductions to "be equitably apportioned between the lessor and lessee." This might have made sense for boosting scarce oil reserves, but why mines and gas wells? The generosity would lead to mischief with tax refund applications because industry interpreted the law liberally.

Realizing it had been too generous, Congress pulled back a bit in the Revenue Act of 1921, limiting the discovery value depletion deduction to 100 percent of net income. The purpose was to prevent the offset of profits from a separate business.5 Railroad and gaslight companies entered the oil business to claim depletion that would wipe out the reported income from their other businesses.6

In 1924 Congress limited the depletion allowance to 50 percent of net income but made the determination of 1913 valuation more generous by codifying that market value could be used:
    It is alleged that the Treasury Department in valuing the stock of close corporations, as of March 1, 1913, has given insufficient weight to the value of the assets as of that date and too great weight to forced or isolated sales of comparatively small blocks of the stock.7
The 50 percent limitation was imposed because the 100 percent limitation permitted companies to make dividend distributions tax free to both the corporation and shareholders.

Congress allowed this still-generous depletion to survive because of the large risks involved in drilling many wells, most of which turned out to be dry holes.

Depletion Scandal

By the 1920s the Bureau of Internal Revenue was evolving into an agency known for graft, bribery, intimidation, widespread corruption, and secret deal-making. Since its formation in 1862, there had never been an investigation of the bureau.

The first investigation resulted from the efforts of James Couzens, the financial genius behind Ford Motor Co., who went on to a career in politics. As Detroit's police commissioner, he fought corruption, and later, as mayor, he installed the municipal streetcars. Couzens was appointed to the Senate in 1922 to complete the two years remaining in Republican Truman Newberry's term after Newberry resigned amid a campaign finance scandal.

Couzens's opening shot came on February 21, 1924. After accusing the bureau of graft, he introduced a resolution calling for the creation of a select committee to investigate. The Senate intentionally omitted funding for legal counsel from the resolution. So Couzens hired Francis J. Heney, the famous "terror of graft" prosecutor, and paid him from his own pocket.

The bureau's files on all the corporations owned by Treasury Secretary Andrew Mellon were subpoenaed. President Calvin Coolidge protested that if wealthy Couzens were permitted to pay for legal counsel for an investigating committee, the Constitution would be subverted — or worse, Mellon might be forced to resign.8

The committee report found extensive evidence of incompetence and favoritism at the bureau. Major abuse of the depletion allowance was a central finding. Among the questionable practices uncovered was the improper refunding of tax payments.9

Businesses were taking advantage of a pro-business Bureau of Internal Revenue climate to amend prior-year tax returns and correct "erroneous" calculations of depletion, claiming huge refunds under a five-year statute of limitations. From 1922 to 1926, Treasury paid over $1 billion in refunds, plus 6 percent interest, to the nation's leading corporations. Mellon was the founder and principal owner of Gulf Oil Co., which received $4.6 million. Standard Oil of California received $3.4 million, and Sinclair Consolidated Oil Corp. got $5 million.

The companies receiving the refunds calculated depletion on the capitalized value of oil leases, discounted at 5 percent for Gulf Oil. The average oil investor never expected less than a 15 percent discount, sometimes reaching 40 percent. A low discount percentage made the underlying property appear more valuable, thus increasing cost depletion.

The 1918 law increased the propensity for mischief by allowing property to be valued as of March 1, 1913, rather than the actual purchase date, and under some circumstances, at the date of discovery of oil or gas (which gave a much higher valuation). As noted earlier, this deduction was split "equitably" between lessor and lessee.

When Gulf Oil discovered that Treasury would accept an absurdly low 5 percent valuation with these loose rules, it applied for huge refunds. The committee report noted, "The allowances to Gulf Oil Corporation are so excessive as to constitute gross discrimination against even the oil industry."

Couzens uncovered collusive and unethical accountants who filed questionable refund claims prepared for a contingency fee. At the time, the American Institute of Accountants (AIA) had an absolute prohibition against contingent fees. A.C. Ernst, managing partner of Ernst & Ernst CPA in Cleveland, was not an AIA member.10 He secured the Gulf Oil account by preparing a $3.78 million tax refund claim. It hinged on application of the 5 percent discount rate applied to lease values, thereby generating enormous depletion deductions — and ultimately a contentious Senate hearing. Here is how Couzens questioned Ernst on the issue:
    Couzens: Can you explain to me how it is possible to give a larger credit for [depletion] than the earnings of the company show?

    Ernst: I think this would be more clear if it would be of any advantage to you gentlemen, to refer to the Government regulations on this subject. They are quite exhaustive and quite clear and were made in 1919. 11
Price Waterhouse's managing partner, George May, appeared before the committee and gave his theory about the 5 percent discount rates. He said they originated with practices of Michigan and Minnesota tax assessors, who applied 4 and 5 percent valuation rates in overvaluing (and overtaxing) mines: "It was very difficult to resist the argument of the taxpayer that he is entitled to at least as high a valuation for depletion as he is for the purpose of tax on capital. That, to my mind, started off depletion valuations on a high level."12

The refunds were not illegal, but Couzens exposed how the process had been corrupted. Historian Matthew Josephson summarized the situation:
    Mobs of corporation accountants and lawyers, all demonstrating how oddly "stupid" they had been in other times, what whimsical errors of overpayments of taxes had been made, the sum of which they drew up and had duly honored by the treasurer.
The Mellon refunds were granted in great haste because Mellon wanted all the cases involving outside interests with which he might be connected closed before March 4, 1921 — the day he would take office. Gulf Oil's amended returns were filed on February 19, 1921, the taxpayer's valuation reports were accepted as filed, and the refunds were approved on February 28, 1921. Ordinarily, such large refunds required one to two years for processing. These revelations tarnished Mellon's reputation. He was accused of abusing his high office for personal gain through his control of the bureau.

Couzens' efforts established that Congress should have a say in formulating tax policy. His investigations resulted in formation of the Joint Committee on Taxation in 1926 to oversee tax laws and their administration.

In 1928 the JCT's authority was extended to review all refunds exceeding $75,000 and publishing an annual report for Congress with the taxpayers' names and the refund amounts. And in 1929 President Hoover issued an executive order that refunds exceeding $20,000 be publicized. The threshold is now $2 million. 13

History books refer to the scandal of 1924 as Teapot Dome, rarely mentioning the Couzens revelations. Teapot Dome, a scandal involving President Harding administration officials, concerned the secret leasing of Navy oil reserves in Wyoming for $400,000 in graft. Both scandals broke at the same time and both involved oil. But the Bureau of Internal Revenue scandal dominated newspaper front pages and involved much more money.

Extraordinary Tax Benefits

Percentage depletion14 for oil and gas wells was introduced in 1925 legislation. At that time it was argued that oil was different from other minerals. The House wanted a 25 percent depletion deduction; the Senate wanted 30 percent. They compromised at 27.5 percent:
    We can measure the thickness of the seam of coal, we know its area, and we can calculate with considerable accuracy the tonnage that is in the ground. We do not discover coal in the same way that we discover oil. There is not the element of uncertainty about it....Ever since early war days Congress has followed the policy of allowing what they call discovery value for both oil and gas wells and for minerals.

    Endeavoring to come at the rule of thumb, the Finance Committee decided to base the tax on gross income from the well; and they decided, after long consideration that 25 percent of the gross income was about fair... we realized that it was going to be a great help to the owners of these little wells which barely pay the cost of pumping and keeping cleaned out. We tried to strike approximately the correct point between the two extremes.15
In 1932 similar treatment in varying percentages was afforded to the owners of iron, coal, sulfur, and metal mines — one of the few tax reductions during the Great Depression. Congress also instituted an irrevocable election that a taxpayer had to make, effective for returns filed in 1933, to claim either cost or percentage depletion. The percentage depletion allowance was set at 5 percent for coal mines, 15 percent for metal mines, and 23 percent for sulfur mines.
With World War II underway, those privileges were extended in 1942 to fluorspar, rock asphalt, and ball and sagger clay, and in 1943 to vermiculite, potash, feldspar, mica, talc, lepidolite, barite, and spodumene, in some cases without a showing that current output was inadequate for war needs.

The Revenue Act of 1943 added "ordinary treatment processes" to the definition of mining because the product was not marketable as raw ore without processing.16 Thus, gross income from mining was expanded to include not just mere extraction of ores or minerals from the ground but also treatment processes. That further inflated the amount that could be claimed as percentage depletion, thereby sheltering even more income from taxation. As discussed below, the costs of transportation from the mines to processing plants would soon be added as well.

World War II ended 66 years ago, but questionable legacy bounties continue. The Revenue Act of 1943, which enacted many of these provisions, is among that rarest type of legislation: a tax law passed by a congressional override of a presidential veto.17 It extended depletion to common minerals with no evidence that there was a shortage of those products or that production would increase as a result of the incentives.

When capital gains treatment was extended in 1943 to cutting timber,18 the top ordinary income tax rate was 91 percent. The need to qualify for lower 25 percent capital gains rate was justified because "timber owners are seriously handicapped under the Federal income and excess profits tax laws."19

That became the third ground for the veto, with President Roosevelt saying: "As a grower and seller of timber, I think that timber should be treated as a crop and therefore as income when it is sold. This would encourage reforestation."

Powerful members of Congress were angered, with Sen. Walter George saying, "The president, in striking down the potash amendment and in specifically condemning the timber amendment, unwittingly has struck agriculture and forestry very definite and staggering blows." 20 He was referring to the once-in-a-lifetime sale of 50-year hardwood timber. Roosevelt's timber experience was selling Christmas trees, an easy growth with a short life. The election for capital gains treatment applies to all trees. The tax benefit was later extended to capital gains for the sale of coal and domestic iron ore.

By 1945, more than 400,000 barrels of daily U.S. crude oil production came from fields and pools discovered after Pearl Harbor. The Petroleum Administration for War estimated that for 1945 it would be necessary to drill 27,000 development and exploration wells for oil and gas, including 5,000 wildcat wells. That was the amount estimated to sustain the production of petroleum essential for the maintenance of our military and civilian requirements. Petroleum needs would be equally great for 1946.21

So in 1945 Congress added an optional deduction for intangible drilling and development costs for oil and gas wells, to affirm the validity of Treasury regulations that allowed the deduction, which had been questioned in a recent court action.22 A taxpayer could elect to either capitalize or expense intangible drilling and development costs, which was expanded in 1950 to "development of mines."23

In 1950 the definition of mining was amended to include the expense of transporting ores and minerals from the point of extraction to the plants or mills in which the ordinary treatment processes are applied.24 The committee reports noted that this provision would apply to the transportation of clay to a brick-making plant, as well as coal and other ores and metals to a processing plant. The flimsy reason given was that the products had no value until they reached the processing plant.25

Oil and gas depletion was reduced from 27.5 to 22 percent in 1969 and limited to 50 percent of taxable income. Following the 1973 Arab oil embargo and the large profits that accrued to oil companies, percentage depletion for oil and gas was repealed in 1975 with exceptions for small producers and some prior contracts.26

This was our nation's original energy and strategic minerals policy. The extraordinary became ordinary, and those provisions have become a permanent fixture in our tax statutes with some minor modifications, even though our oil reserves up through the 1950s appeared to be increasing rather than diminishing. Percentage depletion sections 613 and 613A haven't been revisited since 1975.

What's unique about depletion is that it does not stop when the property has paid for itself, as with depreciation on buildings and machinery; instead, it goes on as long as production continues. Further, the percentage depletion deduction increases with commodity price inflation. Former Treasury counsel Randolph Paul complained in 1947 that the average allowance for oil consistently ran about six times the actual depletion sustained on actual cost: "Comparable treatment of [manufacturers] would permit charging the cost of part of physical plant to expense and the continued deduction of depreciation until the amounts charged off aggregated six times the original cost of the plant."27

The Windfall Oil Profit Tax

First proposed by President Gerald R. Ford in 1974,28 the Crude Oil Windfall Profit Tax Act of 1980 was passed during President Carter's administration. It was an excise tax imposed on the difference between the market price of oil and a statutory 1979 base price that was adjusted quarterly for inflation and state severance taxes.

The Constitution requires that all duties, imposts, and excises be uniform throughout the United States. A district court held that the act was a clear violation because it exempted oil produced in Alaska while taxing oil produced in Texas and elsewhere. About $30 billion in refunds — and billions more in lost future revenues — were at stake if the district court's decision was upheld. The deficit-plagued Reagan administration could ill afford a defeat.

In one of its cleverest decisions, the Supreme Court declared that the term "exempt Alaskan oil" really meant oil produced in specified Arctic and sub-Arctic regions. The exemption applied to all states with oil-producing territory above the 49th parallel. It was irrelevant that only Alaska is above the 49th parallel. 29

Congress repealed this tax in 1988 after crude prices declined below adjusted base prices, resulting in zero windfall profit tax. Original revenue forecasts turned out to have significantly overestimated future crude oil prices. The windfall profit tax generated 1980-1990 gross tax revenue of about $80 billion, or 80 percent less than the projected $393 billion.

The tax increased the nation's dependence on imported oil by taxing only domestically produced oil. Because the tax couldn't be passed on to consumers in the form of higher oil prices, it is blamed for a reduction in domestic oil production of between 1.2 and 4.8 percent.30

In light of this experience, it seems reasonable to discount oil company executives' threat that repeal of their tax bounties might increase gasoline prices. These companies probably lack the ability to pass on lost tax benefits to consumers. The effect of repeal on future domestic oil production requires further study.

Presidential Politics

Depletion was a popular party platform in presidential elections.
Republicans started by including "continuance, for tax purposes, of adequate depletion allowances on oil, gas and minerals" in their 1944 party platform.31 The platform made no other specific tax recommendations, and was repeated in subsequent years until 1992.32

President Nixon supported the depletion allowance in his 1960 presidential campaign, arguing:
    Depletion allowances are not only a longstanding element in mineral economics; they have demonstrated their value as a reasonable incentive for the development of the Nation's natural mineral resources. They should be maintained at present levels. In a few select instances, such as those of oil, shale, and coal to be used for synthetic liquid fuels, depletion allowances might be increased to encourage development of new minerals industries. In addition, the existing limitation on expensing exploration costs should be removed and replaced with a new limitation of $100,000 per year per taxpayer without any other restrictions.33
Not surprisingly, the 1960 Democratic party platform took an opposing view: "Among the more conspicuous loopholes are depletion allowances which are inequitable." By 1972, Democrats had modified their platform: "The tax law is clogged with complicated provisions and special interests, such as percentage oil depletion and other favors for the oil industry."34

That view was not shared by the party's 1960 presidential nominee, who wrote, "I have consistently throughout this campaign, made clear my recognition of the value and importance of the oil-depletion allowance....The oil-depletion allowance has served us well by this test." President Kennedy favored a new comprehensive study to determine the proper depletion incentives along the lines of the Paley Commission report of 1952.35 Of course, Kennedy's running mate, then-Sen. Lyndon B. Johnson, was from oil-state Texas and a strong supporter of the oil depletion allowance.

This should not be a partisan issue, even if the party platforms take opposing positions. President Ronald Reagan suggested an accommodation that wasn't enacted in his 1986 tax reform:
    Under our new tax proposal the oil and gas industry will be asked to pick up a larger share of the national tax burden. The old oil depletion allowance will be dropped from the tax code except for wells producing less than 10 barrels a day. By eliminating this special preference, we'll go a long way toward ensuring that those that earn their wealth in the oil industry will be subject to the same taxes as the rest of us. This is only fair. To continue our drive for energy independence, the current treatment of the costs of exploring and drilling for new oil will be maintained.36

Call for Review

Oil and gas incentives aren't the only ones sorely in need of a major overhaul. We now have an opportunity to revisit all the 100-year-old tax bounties conferred on a small group of preferred taxpayers: mines, the timber industry, and a nascent "clean energy" industry.

There has not been a comprehensive review in 60 years, which has resulted in a stale list of early 20th century incentivized minerals. Rare-earth elements, which are the 21st century minerals, may be in need of continued, perhaps increased, incentives. They are required in consumer electronics (iPods, cellphones), powerful magnets (hybrid autos, miniature motors), precision technology (lasers, GPS, and cruise and Patriot missiles), and computers, among many other high-tech applications.37

China currently fulfills 95 percent of the global demand for those refined, scarce minerals. Molycorp Minerals' Mountain Pass, a California mine in the Mojave Desert, has the largest non-Chinese rare-earth deposits on Earth. This single mine once supplied most of the world's needs.

Rare-earth elements are expensive to extract, are often laced with radioactive elements, and must be refined to more than 99.9999 percent purity to be useful. Even 99.9 percent purity is inadequate for many applications. All the processing facilities for this complex high refinement are in China. Molycorp has on-site facilities that can bring raw ore to intermediate refinement, but it must then ship the product to China for final upgrade.38

What makes rare earths "rare" is not actual scarcity, but high refinement. China came to dominate the market because it processes those elements more cheaply and with fewer environmental restrictions than its competitors. Molycorp's financial statements do not list cost depletion, perhaps because the cost on its pre-World War II mine has long been recovered. Any percentage depletion under those circumstances is purely a tax exemption.

We provide the same 22 percent depletion for clay and sulfur as rare earths. Was there ever a valid reason for a depletion allowance for clay used in brick-making, including the cost of transporting it from the mine to the factory and processing plant?39

This anachronistic tax policy is overdue for a thorough review. Which minerals today deserve a tax subsidy? Our objective should be to avoid creating a new dependence on Chinese rare earths. Some of the answers may lie in regulatory, environmental, and trade policies rather than tax policy.

While anger is directed at big oil, which no longer qualifies for percentage depletion, gold and silver — which have also had big price rallies — still receive a 15 percent depletion allowance.

General Electric Co. has received extensive negative publicity for not paying any U.S. income tax on $14.2 billion in 2010 worldwide profits, including $5.1 billion from U.S. operations.40 Among other bounties, Congress gave GE a $75 million credit for manufacturing energy-efficient appliances.41 Exported appliances qualify for this credit. Does providing GE this incentive for producing its most expensive top-of-the-line appliances contribute to our nation's energy independence, particularly if they are exported?

Ethanol initiatives originated in 1978 and expanded.42 It quickly became a triple-subsidy, as its use is mandated by law, enjoys protective tariffs, and blenders receive federal subsidies, costing taxpayers nearly $6 billion a year.43 The threshold question should be whether conversion of food into fuel should be subsidized at all, or even cellulosic ethanol should be the main subsidized alcohol technology.

Oil shale receives a 15 percent depletion allowance. Perhaps we should direct more incentives to shale rather than ethanol — or direct those incentives toward developing more environmentally friendly shale extraction methods.44

A $7,500 tax credit is available for purchasing a Chevy Volt or Nissan Leaf. Government grants gave Korea's LG Chem an almost free battery plant, amounting to an additional several hundred dollar subsidy for each Volt battery45 (not to mention the government bailout of General Motors and depletion allowance for lithium, the battery's main component).

Massachusetts-based battery producer A123 Systems Inc. was eliminated from the competition to produce batteries for the Volt, but it still built a U.S. plant with government grants.46 It remains to be seen whether the company's plants will be used merely for assembling batteries produced abroad.47

The controversy over tax benefits for mineral extraction has been ongoing for nearly 100 years. It has often been suggested that these are gifts to corporations and shareholders. Yet the political will to end — or to comprehensively review — these tax bounties has always been lacking.

The current controversy, with some politicians threatening oil companies with higher taxes, is an opportunity for true reconsideration of all mineral tax benefits. Most of those provisions originated in an era when Congress, Treasury, and the Bureau of Internal Revenue were perhaps lopsidedly more pro-business than even today's conservatives might accept.

President Harry S. Truman understood this issue:
    I am well aware that these tax privileges are sometimes defended on the grounds that they encourage the production of strategic minerals. It is true that we wish to encourage such production. But the tax bounties distributed under present law bear only a haphazard relationship to our real need for proper incentives to encourage the exploration, development and conservation of our mineral resources. A forward-looking resources program does not require that we give hundreds of millions of dollars annually in tax exemptions to a favored few at the expense of the many.48
In conclusion, it's not just oil companies whose tax benefits should be revisited. It's the whole patchwork of depletion and other bounties that are retained as accidents of history and modern entitlements based on weak, discredited, or anachronistic ideas that are no longer valid or were never valid in the first place. What began as percentage depletion only for oil and gas was extended to other minerals and largely repealed for oil and gas.

The function of oil and mineral bounties should be to provide appropriate tax incentives where needed to develop new resources that are in short supply. Technology and national needs have changed over the last century, but we retain century-old law that may have outlived its purpose.

Determining the size of an oil or mineral deposit is not as haphazard as it was 100 years ago, which was the major justification for adopting percentage depletion. Indeed, the entire regime of percentage depletion for all minerals should be reconsidered. Besides some tweaking in 1969 and a political repeal for major oil companies in 1975, there has never been a comprehensive review of the need for these incentives.

A byproduct of properly revisiting the incentives will be a significant simplification of tax law, some reduction in the size of the code, and an increase in tax revenues.


1 JCX-27-11 (11 May 2011). The list consists of the credit for enhanced oil recovery costs (section 43), the marginal well tax credit (section 45I), the expensing of intangible drilling costs (section 263(c)), the deduction for qualified tertiary injectant expenses (section 193), the amortization period for geological and geophysical costs (section 167(h)), percentage depletion (sections 613 and 613A), the deduction for income attributable to domestic production of oil and gas (section 199), the exception from passive loss rules for working interests in oil and gas property (section 469), foreign tax credits for dual-capacity taxpayers (section 901; reg. section 1.901-2(a)(ii)), and the last-in, first-out inventory method (section 472).

2 Franklin D. Roosevelt, "Message to Congress on Tax Evasion Prevention" (1 Jun 1937) (containing a 29 May 1937 letter on tax evasion prepared by Morgenthau).

3 "New Income Tax Rulings," New York Times, 2 Feb 1918, at 10.

4 S. Rep. No. 65-617 (1918); J.S. Seidman, Seidman's Legislative History of Federal Income Tax Laws 1938-1861, 916 (1938).

5 S. Rep. No. 67-275 (1921); Seidman, supra note 4, at 836.

6 61 Cong. Rec. 6111 (Senate); Seidman, supra note 4, at 837.

7 S. Rep. No. 68-398 (1924); Seidman, supra note 4, at 708.

8 Appointed by President Warren G. Harding, Mellon presided over a period of such unprecedented financial prosperity that he was hailed as the greatest Treasury secretary since Alexander Hamilton, an appellation he was quite fond of. He served for 12 years, and it's said that three presidents served under him.

9 Bernard D. Reams Jr., ed., "Select Committee on Investigations of the Bureau of Internal Revenue" in U.S. Revenue Acts 1909-1950 (1979) (more than 5,000 pages of committee testimony and reports from the Couzens investigation — March 14, 1924, to February 2, 1926 — is in volumes 3 through 6 of this 144-volume collection); Fred F. Sully, "Those Refunded Millions," Saturday Evening Post, 21 Jun 1924, at 36; "Shows Big Refunds in Oil Firms' Taxes," New York Times, 11 Dec 1925, at 10 (list of big corporate refunds); "Couzens Report Charges Tax Loss of $308,000,000," New York Times, 13 Jan 1926, at 1; Harry Barnard, "Granddaddy of the Tax Scandals," The Nation, 19 Jan 1952, at 57.

10 Ernst's resignation from the AIA is discussed in John L. Carey, Rise of the Accounting Profession From Technician to Professional, 1896-1936, 233-234 (AICPA, 1969).

11 Reams, supra note 9, at 306 (27 Mar 1924).

12 Id. at 249, 269 (26 Mar 1924).

13 In 2009 the JCT examined 518 refund cases involving more than $16 billion, but without publicity. JCT release (15 Mar 2011), Doc 2011-5476

14 Percentage depletion allows a deduction for a percentage of the property's gross income from taxable income, and it can exceed the value of the property. Cost depletion is calculated with reference to the property's basis, total recoverable units, and number of units sold, and it is limited to the property's cost.

15 Sen. Jack Reed (D-RI), 67 Cong. Rec. 3766-3767 (1926); Seidman, supra note 4, at 586.

16 Former section 114(b)(4)(B) (Internal Revenue Code of 1939); section 613(c)(2), (3), and (4); S. Rep. No. 78-627 (1943), at 55; Seidman's Legislative History, 1953-1939, at 1695-1996.

17 It was an overwhelming veto override. The vote was 299 to 95 in the House and 72 to 14 in the Senate.

18 Former section 117(k) (1939 IRC); section 631(a).

19 S. Rep. No. 78-627 (1943); Seidman, supra note 16, at 1824.

20 90 Cong. Rec.. 1949-1950; Seidman, supra note 16, at 1827.

21 Former section 23(m) (1039 IRC); H.R. Rep. No. 79-761 (1945), at 1-2; 91 Cong. Rec. 7892-7893 (1945); Seidman, supra note 4, at 1361-1362.

22 H.R. Con. Res. 50 (1945); section 263(c).

23 Former section 23(cc) (1939 IRC); section 616.

24 Former section 114(b)(4) (1939 IRC); section 613(c)(2).

25 Remarks of Rep. Ed Case, 96 Cong. Rec. 13275 (1950); Seidman, supra note 16, at 1692.

26 Section 613A.

27 Randolph Paul, Taxation for Prosperity 306 (1947).

28 Ford, "Message to the Congress on Legislative Priorities" (12 Sep 1974).

29 United States v Ptasynski, 462 US 74, 81 (1983), rev'g 550 FSupp 549 (D. Wy. 1982).

30 Salvatore Lazzari, "The Crude Oil Windfall Profit Tax of the 1980s: Implications for Current Energy Policy," Congressional Research Service, RL33305 (9 Mar 2006), 2006 TNT 50-35; Joseph J. Thorndike, "Historical Perspective: The Windfall Profit Tax — Career of a Concept," Tax Notes, 14 Nov 2005, p. 863, 2005 TNT 219-11.

31 See

32 Republican party platform:
    1952: "We favor reasonable depletion allowances."

    1956: "We favor reasonable depletion allowances."

    1960: "Continued support for federal financial assistance and incentives under our tax laws to encourage exploration for domestic sources of minerals and metals, with reasonable depletion allowances."

    1964: "Continued tax support to encourage exploration and development of domestic sources of minerals and metals, with reasonable depletion allowances."

    1992: "We support incentives to encourage domestic investment for onshore and OCS oil and gas exploration and development, including relief from the alternative minimum tax, credits for enhanced oil recovery and geological exploration under known geological oil fields and producing geological structures, and modified percentage depletion rules to benefit marginal production.

33 Richard Nixon, "Natural Resources Study Paper," 29 Oct 1960.

34 Democratic party platform: (1960); (1972).

35 Letter from John F. Kennedy to Gerald C. Mann on oil depletion allowance (13 Oct 1960). The letter references the Paley commission report (President's Materials Policy Commission, "Resources for Freedom" (1952)). For a 1972 summary and update, see Alex S. Lang, "A Crisis in Critical Commodities," Division of International Finance, Board of Governors of the Federal Reserve System, RFD #6960, Discussion Paper No. 17, 1 Sep 1972.

36 Ronald Reagan, "Address to the Nation on Tax Reform," 28 May 1985.

37 Leo Lewis, "Digging for Victory: How Rising Powers Hold the Key to the Future," Financial Times, 27 Aug 2010; Javier Blas, "Commodities: In Their Element," Financial Times, 29 Jan 2010.

38 Byron King, "Problematic Supply of Rare Earths Will Escalate Into a Crisis," Financial Times, 3 Feb 2010.

39 Section 613(b).

40 David Kocieniewski, "G.E.'s Strategies Let It Avoid Taxes Altogether," New York Times, 24 Mar 2011.

41 Section 45M(e).

42 Energy Tax Act of 1978 (P.L. 95-618); sections 40, 4041(b)(2), 4041(m), 4083(a)(2), 6426, 6427(e). Ethanol is also protected under items 9901.00.50 and 9901.00.52 of the Harmonized Tariff Schedule of the United States. The Senate on June 16 added an amendment to a spending bill, S. 782, the "Economic Development Revitalization Act of 2011." Upon passage, which isn't assured, the amendment would repeal sections 6426(b)(6) and 6427(e)(6)(A) and replace Harmonized Tariff Schedule Item 9901.00.50 with 9823.01.01 placing ethanol for use in a gasoline on the "free" list. Absent Congressional action, these tax credits are automatically set to expire on December 31, 2011 anyway.

43 "Feinstein Applauds Senate Passage of Ethanol Tax Credit Repeal," Tax Notes, 16 Jun 2011, 2011 TNT 117-39.

44 "The Need to Be Seen to Be Clean," The Economist, 14 May 2011, at 37.

45 Section 30B(d)(2)(B)(iii)(I). Korea's LG Chem was provided with $150 million federal economic stimulus funds plus $100 million from Michigan. Matthew L. Wald, " $2 Billion in Grants to Bolster U.S. Manufacturing of Parts for Electric Cars," New York Times, 6 Aug 2009, at 5.

46 Press release, A123Systems, "A123Systems Awarded $249M Grant from U.S. Department of Energy to Build Advanced Battery Production Facilities in the United States," 5 Aug 2009; press release, A123 Systems, "A123 Systems Awarded $100 Million in Refundable Tax Credits from Michigan Economic Development Corporation," 14 Apr 2009.

47 A123Systems has four manufacturing facilities in Korea and China.

48 Harry Truman, "Special Message to the Congress on Tax Policy," 23 Jan 1950.



Jay Starkman, CPA is a sole practitioner in Atlanta. This article was originally published in Tax Notes, July 11, 2011.